Problem set 3

1. Hemingway Corporation manufactures and sells construction and mining equipment, diesel and natural gas engines, industrial gas turbines, and diesel-electric locomotives in the United States. The company is considering expanding its operations worldwide to boost its income and cash flows. The expansion project will require the company to raise $100 million capital to finance the project. Mike Schenk, MBA has been hired to assist the company with the preparation of financial statement analysis and to suggest actions needed to raise the needed funds. Schenk is directed to send copies of the financial statement analysis to management of the company, potential lenders, and strategic investors. The balance sheet and income statement for the company are shown below.

Balance Sheet (Millions of Dollars)

	2019	2020	2021Est.
Assets
Cash and equivalents	62	52	52
Short-term investments	102	12	52
Accounts receivable	402	522	532
Inventories	640	840	680
Total current assets	1,206	1,426	1,316
Net fixed assets	2,920	3,520	3,720
Total assets	4,126	4,946	5,036
Liabilities and equity
Accounts payable	330	430	365
Notes payable	182	252	120
Accruals	200	240	272
Total current liabilities	712	922	757
Long-term bonds	800	1,100	1,100
Total liabilities	1,512	2,022	1,857
Common stock (100,000 shares)	1,000	1,000	1,000
Retained earnings	1,650	1,924	2,216
Total common equity	2,650	2,924	3,216
Total liabilities and equity	4,126	4,946	5,036

Income Statement (millions of Dollars)

	2019	2020	2021Est.
Net sales	6,500	7,000	7,600
Cost of goods sold	4,400	4,800	5,320
Depreciation	292	322	372
Other operating expenses	360	400	410
Earnings before interest and taxes (EBIT)	1,448	1,478	1,498
Less interest	68	108	100
Pre-Tax earnings	1,380	1,370	1,398
Taxes (25%)	345	343	350
Net Income	1,035	1,028	1,049

Industry average for selected ratios

Profit margin	16.0%	Inventory turnover	6.0
Operating profit margin	22.0%	Fixed assets turnover	2.3
Basic Earning power	35.5%	Total assets turnover	1.6
ROA	25.6%	Current	2
ROE	36.5%	Quick	0.85
P/E ratio	9.4	Debt ratio	30.0%

1. The financial ratio analysis of the company is being conducted for management, equity investors, and long-term potential creditors. Explain the primary emphasis of each of these groups in evaluating the ratios.

2. Calculate the following profitability ratios for Hemingway Corporation for 2020:

i. Operating profit margin

ii. Return on assets (ROA)

iii. Return on equity (ROE)

iv. Basic Earning Power (BEP)

3. Calculate the following asset management ratios for Hemingway Corporation for 2020:

i. total assets turnover

ii. Fixed assets turnover

iii. Inventory turnover

4. Calculate the following liquidity and debt management ratios for Hemingway Corporation in 2020:

 i. Current ratio

ii. Quick ratio

iii. Debt ratio

5. Explain  trend analysis. Calculate the projected  profitability ratios for Hemingway Corporation for 2021.

6. Using the trend analysis indicate whether the financial performance of Hemingway Corporation has improved or worsened over the years.

7. Explain  benchmarking. Indicate whether the asset management ratios of the company have improved or worsened relative to the industry.

8. Mike Schenk is using the extended Dupont equation to predict the Return on Equity (ROE) for Hemingway Corporation for 2022. He forecasts the following ratios for 2022.

Ratio
Profit margin	16.0%
Total assets turnover	1.6
Equity multiplier	1.7

Calculate the Return on Equity (ROE) for Hemingway Corporation for 2022.

9. Mike Schenk explains to the CEO that although financial ratio provides useful information concerning the company’s operation, it has limitations that necessitate care and judgment. Identify  four  limitations of ratio analysis that Mike is addressing.

10. In the report sent to investors and credit lenders, Mike indicated that financial statement analysis goes beyond comparing ratios, and that qualitative factors must be considered as well. Identify  five  such qualitative factors that the users of the financial statement should consider when evaluating the company’s future financial performance.

Submit your answers in a Word document.